A Note on Discounting and Funding Value Adjustments for Derivatives

18 Pages Posted: 19 Feb 2013 Last revised: 9 Mar 2015

See all articles by Meng Han

Meng Han

RBC Financial Group

Yeqi (Ritchie) He

Royal Bank of Canada

Hu Zhang

Date Written: February 21, 2013

Abstract

In this paper, valuation of a derivative partially collateralized in a specific foreign currency defined in its credit support annex traded between default-free counterparties is studied. Two pricing approaches -- by hedging and by expectation -- are presented to obtain the same valuation formulae. Our findings show that the current marking-to-market value of such a derivative consists of three components: the price of the perfectly collateralized derivative (a.k.a. price by collateral rate discounting), the value adjustment due to different funding spreads between the payoff currency and the collateral currency, and the value adjustment due to funding requirements of the uncollateralized exposure. These results generalize previous works on discounting for fully collateralized derivatives and on funding value adjustment for partially collateralized or uncollateralized derivatives.

Keywords: CSA, collateral, foreign collateral, derivative pricing, hedging, martingale pricing, FVA, funding cost, funding and discounting

JEL Classification: G12, G13

Suggested Citation

Han, Meng and He, Yeqi (Ritchie) and Zhang, Hu, A Note on Discounting and Funding Value Adjustments for Derivatives (February 21, 2013). Available at SSRN: https://ssrn.com/abstract=2220371 or http://dx.doi.org/10.2139/ssrn.2220371

Meng Han

RBC Financial Group ( email )

200 Bay Street
11th Floor, South Tower
Toronto, Ontario M1C5E9
Canada
416-842-9915 (Phone)

Yeqi (Ritchie) He

Royal Bank of Canada ( email )

Canada
416-974-3496 (Phone)

No contact information is available for Hu Zhang

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